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Healthcare ETF in Focus on Earnings Reports

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With the first quarter earnings season gathering steam, the results of major companies have dictated recent market trends. Weak earnings from some of the banking giants pushed the financial sector ETF (XLF - ETF report) down, while tech ETFs (such as (XLK - ETF report) also slumped on the back of weak earnings by Apple and some of the other big tech firms.

According to S&P Capital IQ, with results from about 271 companies in the S&P 500 index already in, first-quarter earnings for companies in the S&P 500 are now on track for a gain of 3.6% versus a year ago.

This week, investors should turn their focus to the healthcare ETF Health Care Select Sector SPDR Fund (XLV) as two of the industry’s bellwethers are scheduled to report their first quarter earnings. Pfizer and Merck are the two companies in line to report, and both companies play a huge role in the fund’s returns (3 Sector ETFs Surviving This Slump).

Pfizer holds the second position in XLV and has a dominant role in the performance of the ETF with a share of 11.98% in the fund. On the other hand, Merck gets the third position in the ETF with a share of 7.88%. In other words, the two combine to make up nearly one-fifth of the total returns in the ETF, suggesting that their reports will be big drivers of the fund this week.

Recent History

The ETF has performed relatively well delivering a return of 19.2% year to date, so expectations could be high for Pfizer and Merck. However, both are just have Zacks Ranks of 3 or ‘Hold’ so their reports could be mixed based on our models.

Still, for investors looking to trade the sector, it is worth noting that XLV is quite favorable to traders, as it has a huge volume and AUM approaching $8 billion. Though, the fund is heavily concentrated in its top holdings, as the ten biggest firms make up just under 60% of total assets (5 Sector ETFs Surging to Start 2013).

Other Key Aspects of XLV

Beyond the two aforementioned giants, investors should note that Johnson & Johnson gets the first position in the fund. In fact, the top three holdings get one third of the asset allocation, thereby playing a dominant role in the performance of the ETF.

The ETF represents a varied group of stocks that belong to pharmaceutical (48.29%), healthcare equipment and supplies (16.28%), healthcare providers & services (15.47%) and biotechnology (15.46%). The fund charges a fee of 18 basis points.

Healthcare Sector in Focus

The U.S. healthcare sector is one of the potential bright spots as the country is one of the major markets for healthcare and one of the largest spenders on public health, putting the sector in an advantageous position.

The sector has been in focus despite profitability remaining under pressure for many companies, and some policy uncertainty with regards to the Affordable Care Act.

The healthcare sector is expected to remain in growth territory, in 2013, given the aging population and higher rates of chronic diseases, growing demand in emerging markets and new product launches (4 Best ETF Strategies for 2013).

The increase in market size combined with inorganic growth for many companies in the form of mergers and acquisitions would help counter the recent decline in revenues seen across the board in the pharma sector. It would also address the issue of the patent cliff that has lately affected the big companies.

In fact, the pharmaceutical industry is showing signs of recovery from one of the biggest patent cliffs in recent times. The last few quarters saw major blockbusters like Merck’s Singulair and Pfizer’s Lipitor losing patent protection. These products alone represented branded sales worth more than $15 billion.

However, the effect of these going generic was felt mostly in 2012. While the industry won’t be completely free from more key products going generic, the major patent expiries are over and done with. New products should start contributing significantly to results and increased pipeline visibility and appropriate utilization of cash should increase confidence in the sector.

The pharma sector has also witnessed major merger and acquisition (M&A) activity over the last couple of years. Going forward, these small bolt-on acquisitions are expected to continue. A significant pickup in in-licensing activities and collaborations for the development of pipeline candidates is also expected going forward (Zacks Top Ranked Healthcare ETF: FXH).

Bottom Line

The near future of health care is uncertain, as Obamacare fully gets underway. Many pharma companies are also having trouble filling their product pipelines as new drugs go off patent.

However, the sector is still an interesting play due to its defensive nature and its resiliency as of late. And with two key earnings reports due out this week, it could be a very important few days for this key ETF.

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